The Trouble with VAT

Cast your mind back my despised little Englander mates. To when the last group of "Those Who Should Be Obeyed", panicked and adopted the ludicrous concept of dropping VAT by 2.5%.

As if that was ever going to make people stampede to the shops.

It did though cost a shedful of money. Not only that, it had no positive effect on employment within the small businesses.

Now of course the latest group of "Great Good and Extremely Well Fed" plan to raise VAT to 20%.

Granted, it is an easy hit. A way of raising a considerable amount of money in a short time. "As is" this rate increase will probably also have little effect on employment levels.

But VAT does have a big affect on employment. Especially within the small business sector. But this is due to the VAT Registration Threshold.

The VAT Threshold is based on the turnover of a business. If a business has a turnover of £70K or more it must register for VAT. This means that any bill the business issues will be inflated by 20% (i.e. the VAT). However this will be off-set by the business being able to reclaim VAT it has paid to its suppliers.

So how does this effect employment in small businesses?

Take a plumber working as a sole trader. Say his turnover (that's not profit... that's everything) is £68K. He does not have to register for VAT. No VAT registration means he has to absorb the VAT on the goods he supplies but does not have to charge 20% on his labour. As his labour will account for probably 2/3rds of the final turnover, he can charge less (or make more profit) than another plumber with a turnover of £71K.

There is a distinct disincentive to go through the VAT threshold. If you are going to breach it then you need to do it in style (aka turnover £150K etc.).

Now let us assume that our plumber decides to expand and wants to employ a labourer. Automatically the plumbers turnover inflates by the wages paid to the additional employee. The plumber goes through the VAT threshold and now (as well as paying the labourers wages) has to increase his bills by 20%.

The labourer will have to bring in a great deal more work to make his employment viable. In essence it make much more sense for the plumber to leave the labourer on the dole and to take a holiday when his turnover gets too close to the VAT threshold.

This could be fixed by raising the registration threshold to (say) £100K. It would encourage small enterprises (like our plumber) to expand and to do that he would then require the labourer to help him. Multiply that by (say) 300,000 small businesses across the country and you see the affect.

In the cash straitened time the big question is how much would this cost the exchequer? I think the answer is very little. One of the big savings is the labourer is no longer on the dole (and he is paying taxes) also there is the enterprise affect. As he has expanded once, maybe our plumber will hire more people and risk going go through the VAT threshold. But now it won't hurt so much. Relative to his expanded business, the hiring of extra staff is not so monumental.

So raising the VAT threshold could possibly take 300,000 people off the dole maybe more.

Seems like a good idea to me.